Today's Employment Report: Focus on the Long Term Trends

After this morning's employment report, all of the hopefulness that surrounded an impending economic recovery is quickly eroding. With total jobs lost coming in at a worse than expected 190,000, and the unemployment rate finally jumping to 10.2% barrier, gloom and doom are reentering the scene. Those searching for glimmers of economic growth are once again scratching their heads and trying to determine when we will finally see the turn from contraction to growth.

As easy as it is to allow ourselves to become enamored with these short-sighted views, as investors we are better served to take a long-term perspective. Economic data is often revised numerous times and the likelihood of this number standing as a definitive statement of the employment market is virtually zero.

Instead, let us focus on two long-held beliefs that often accompany the release of employment data. The first is that employment is a lagging indicator. When the economy begins weakening, employers are slow to lay off workers with the hope that the slowdown is temporary and robust growth will quickly resume. When they eventually trim jobs, these same employers do not hire staff in anticipation of an economic rebound, but add new jobs only when existing staff cannot handle the influx in new orders. Since the disappearance and creation of jobs both lag the turn in the actual economy, people view employment as a lagging indicator. Following this logic, one cannot associate a still weak economy with a weak labor market.

The second belief is that the stock market is a discounting mechanism and acts as a predicative indicator. Since the value of an asset is the sum of its discounted future cash flows, increases in the stock market are thought to indicate that future economic growth will increase, while declining stock prices show weakness ahead. While studies of investor emotion have damaged the long-held view of the market accurately reflecting the future, arguing that millions of profit-seeking investors are always wrong about the future is a high hurdle to cross. Instead, we should assume the market is an accurate forecaster on most occasions with temporary instances of disconnect.

Following the logic of these two arguments, one could assume that when jobs stop disappearing, the economy will already be in the process of expanding and the market will already be in rally mode in anticipation of this expansion. If we accept these arguments, the only event that could propel the market even higher is increasing employment, which would signal that the economy continues to expand.

To test this theory, I revisited a chart that consistently appears in my weekly newsletter. Since 1948, there have been seven periods of sustained job loss that lasted from nine to 22 months. Looking at where the S&P 500 traded when jobs stopped disappearing and then where the market was when the subsequent growth led to the recovery of those jobs, we see some interesting statistics.

First, before we became a much more service-based economy, the recovery of jobs that had been lost during a recession typically required only nine to 12 months. During the first jobless recovery, which occurred in 1991, that number stretched to 20 months, and after the most recent recession 33 months were needed to recover all those jobs.

Second, the movement of the S&P 500 from the time when jobs stopped disappearing to when they were finally recovered has averaged 13%, with all of the changes falling in a tight range. What has differed is the return delivered to investors. The quick recoveries from 1982 and earlier delivered average annualized gains of 15%, while the most recent recession delivered average gains of 6%.

Looking at these results, I arrive at two conclusions. The first is that the stock market does a solid job of forecasting the future. By the time job losses cease, the stock market has already forecast the turn in the economy and rallied in anticipation of better times. The second conclusion is that those looking to make a quick profit from this market in the years ahead face an enormous hurdle.

As the economic damage suffered in this recession is well beyond any historical comparison other than the Great Depression, I expect the time to recover the 7.4 million lost jobs to be extremely lengthy. If we follow the 2002 format, it would require nearly 10 years. My bet is it will be longer. If we then see the typical 13% rally during this time period, buy-and-hold investors will be left with a slightly higher than 1% annualized return.

Expecting subpar investment returns years into the future, I maintain the stance I have followed for nearly a year. The age of buy-and-hold is gone forever. At times (such as the current rally from the March low) this approach will look brilliant, but only those who are constantly tweaking their risk profiles and looking for opportunity will prosper. We will remain in a decade-long trading range where prices go up and down, but only those who are active will emerge better off.

Comments

[Fueled By R...:]

Lagging indicator or not, employment will not pick up until the situtation in Washington gets sorted out. Few employers wish to hire as long as there are new mandates (healthcare "reform") and taxes (cap and trade, VATs, repeal of 2003 tax cuts) hanging over their heads like the sword of Damocles. It's only logical; why take a risk and expand your business when the Congress might soon greatly increase your cost per employee and then crush demand with new taxes? Logical indeed, except if you're a politician.

Nov 06 09:39 AM

[Teutonic Kn...:]

Politicians made mistakes, they call them "Political Mistakes", and it is always the people who suffer most" - - - [See Note below]

[Note: Quote excerpted from the words of a full colonel (with an Eagle on his shoulder strap) in a 50's black-and-white movie the title of which is forgotten by this commentator.

The movie was about a strayed American Nuclear bomber heading for Moscow, and the colonel was tearfully dragged away from the Air Force Command Center by white-color helmeted MP while uttering those words.]

Teutonic Knight
On Nov 06 09:39 AM Fueled By Randomness wrote:

> Lagging indicator or not, employment will not pick up until the situtation
> in Washington gets sorted out. Few employers wish to hire as long
> as there are new mandates (healthcare "reform") and taxes (cap and
> trade, VATs, repeal of 2003 tax cuts) hanging over their heads like
> the sword of Damocles. It's only logical; why take a risk and expand
> your business when the Congress might soon greatly increase your
> cost per employee and then crush demand with new taxes? Logical indeed,
> except if you're a politician.

Nov 06 09:53 AM

[ryanclarke:]

In this recessionary case Mr. Hannon, employment serves as a LEADING indicator ... not lagging indicator ... of economic health. At least 15% of the U.S. working population now has zero net worth ... and worse ... has a debt burden on average of well over $100k. The debt burden is no longer being payed off on a habitual monthly basis ... and without an increase in jobs ... eventually the banks who own the debt must take losses. As to past economic cycles, the severity of this cycle is demonstrated by the INCREASE in unemployment almost two years after the downturn began ... even though Uncle Sam has pumped money into the system like never before.

Nov 06 10:45 AM

[Harry Tuttle:]

Long term trend (2yrs) doesn't look good. Unemployment has doubled.

Nov 06 11:44 AM

[SeekingTruth:]

Fine analysis and info. Thanks for the hard data.
This dovetails nicely with my comment for Felix Salmon's article "10.2%"

Nov 06 12:10 PM

[Mad Hedge F...:]

nml Ouch! Another 190,000 jobs went down the crapper in October, taking unemployment rate to a new 27 year high of 10.2%. Add in discouraged job seekers, and that puts the jobless rate at gut churning 17.5%, and over 20% in California. Along with yesterday’s stunning, gob smacking 9.5% increase in Q3 productivity, the figures point a giant arc spotlight on what is really happening in the economy. Companies are still firing workers en mass to boost profits. After getting blood from a stone they are returning to the same rock for one more drop. I guess if I fire myself, the profitability of my business would go through the roof too, and maybe even my stock would rise. At least then I would then be rid of my oldest, most expensive but least productive employee, who is the worst to get along with, max’s out his sick and vacation days, and wears the same clothes to work every day, even when there lipstick on the collar. But then who would write this daily letter? Maybe Cecelia, my cleaning lady, would do it. She’s cheap. This explains why when you go into Office Depot these days, there is only one minimum waged employee standing at the cash register, the hours on the phone I have to wait to get technical support from Dell, and the endless unmovable lines at Citibank. America’s service economy has become all about denying service to customers. The scary thing is, with companies firing their way to prosperity, what happens when we get another dip? My theory is that the US has entered an era of chronically high employment that is never going away, no matter what the government does. Goodbye USA, hello Germany!

Nov 06 01:25 PM

[Steve in TN:]

Currently, we're going down the road copying the Western European socialist economies. Unless these clowns are voted out of office we stuck in a high unemployment world. This situation suits the leftist poliitians just fine. Regardless how you feel we need a new "Reagan" now.

Nov 06 02:17 PM

[bbro:]

Let's s see six comments out of seven talk politics and yet no one
talks about the internals of Friday's numbers...worthless...

Nov 07 04:49 PM

[Gary A:]

The author has a conflicted view. First he says 1. that the job creation will be slow, up to 10 years. Then he says 2. the stock market is good at anticipating a turnaround. Then he says 3. that buy and hold is dead. If 1 and 3 are true, I don't think that 2 is true at all, and we could have another credit driven downturn.

That is why I don't think they want to break up the biggest banks. They are Bernanke's best bond customers. That can't go on indefinately, can it?

Nov 08 01:01 PM